Odd Market Reaction to Hawkish Fed Has Two Explanations

Though they remained lower on the day, US Treasury yields pared declines, with traders citing the hawkish tone of the statement.

The U.S. yield curve flattened, with the difference between short-dated two-year Treasury yields and benchmark 10-year yields narrowing to a difference of 78.58 basis points US2US10=RR, the smallest since September 9."It just looks like the Fed is sticking to their story and the market remains highly skeptical that the Fed is going to be able to deliver just based upon underlying data".

The final May results of 1.9% year-on-year and -0.1% month-on-month caused investors to worry that US inflation would not be able to support a third US interest rate in 2017 and the US Dollar dropped.

Market participants' focus will be on signals on the frequency of further hikes and how the Fed plans to unwind its huge Treasury bond stockpile over the years ahead. The rupee opened at 64.34 a dollar and touched a high and a low of 64.26 and 64.37, respectively. Global currency volatility approaches the record lows seen during the summer of 2014 and with major central banks on hold, it may take a black swan event to unfold for it to rebound convincingly.

While most of this week's Eurozone inflation stats have met projections, France's disappointing drop in inflation on Thursday will keep investors anticipating Friday's inflation stats for the overall Eurozone bloc.

Kathy Jones of Charles Schwab sees two possible explanations for why investors may be ignoring the Fed's more hawkish forecasts: Either they don't believe them, or they do believe them, but think the stated path of rate hikes would likely dampen inflation further, forcing the Fed to curtail rate hike plans.

That helped to lift yields on US two-year notes from their lows of the day.

"In this climate, there are no incentives to buy the dollar", she said.

Investors had been anxious that this drop in inflation would have a negative impact on the Federal Reserve's plan to hike U.S. interest rates three times throughout 2017.

By 0806 GMT, the index which measures the dollar's broader strength was up 0.2 percent at 97.145. Meanwhile, the broad based NSE Nifty went up by 10.00 or 0.10% at 9,588.05 with 25 components registering rise. The process could start "relatively soon", Fed Chair Janet Yellen said.

Core retail sales, which exclude automobiles and fuel, decreased by 1.6% in May, compared to forecasts for a 0.8% slide.

The U.S. central bank's rate-setting committee said the economy had continued to strengthen, job gains remained solid and indicated it viewed a recent softness in inflation as largely transitory. Crude traded near a seven-month low. Wellington and Taipei also saw healthy gains but Shanghai ended off 0.3 percent. He notes the Fed has given no indication it will slow the pace of rate hikes it has laid out.

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